Magazine

Online Extra: San Diego's Widening Pension Woes

June 12, 2005

Despite the cool ocean breezes, the political climate in San Diego just keeps getting hotter. On July 26, the city will hold a special election to replace Mayor Richard Murphy, who's stepping down after a scandal involving the city pension fund. He had won reelection last year, following a narrow and hotly contested three-way race. Subsequently, Murphy had a public spat with City Attorney Michael J. Aguirre and was named by Time magazine as one of the nation's three worst mayors.

The unlikely source of Murphy's woes: San Diego's municipal pension fund, which is about $1.4 billion short of the money it needs to pay city retirees over time. Murphy's office had acknowledged that the Securities & Exchange Commission, the FBI, and the U.S. Attorney's office were investigating allegations of securities fraud and public corruption in connection with the fund. Some civic agitators have even called for America's seventh-largest city to declare bankruptcy to help it get out of its financial bind.

STRETCHING PAYMENTS. How did a wealthy city of 1.3 million people get in such a mess? The problem's roots trace back to 1996. During the term of Murphy's predecessor, Susan Golding, the city council voted a big hike in retirement benefits for municipal workers. Rather than increase the city's contributions to the plan, however, the council opted to stretch the contributions out over time. Four years later, as the stock market began to fall and fund assets declined, the city once again looked to limit its contributions.

To do that, the council had to win the permission of a pension-fund board composed largely of labor representatives. The council got permission -- after agreeing to additional benefit hikes. "What we're witnessing is the growing power of labor unions in city affairs," says Steven Erie, a professor of political science at the University of California, San Diego. "They're becoming big players. It's a very serious financial problem."

According to reports produced by Aguirre, the combined cost of the two benefit hikes increased city employee retirement pay by as much as 66%. As of the last fiscal year, the San Diego City Employee Retirement System had $4 billion in liabilities vs. $2.6 billion in assets, a funding ratio of just 65% -- well below a national average of 91%.

TOUGH TALK. Murphy had taken steps to fix the problem. Last November, voters supported his proposal to reconstitute the pension-fund board. Seven of the 13 board members are now independent, with no ties to city employees. In its previous incarnation, just four were independent.

To close the gap in funding, Murphy had hoped to sell hundreds of millions in pension obligation bonds, backed by the city. And he was getting tougher in labor negotiations -- looking to freeze salary and benefit increases, hike employee pension contributions, and reduce benefits for new hires.

The prospect of bankruptcy is remote. Nearby Orange County, Calif., which declared itself insolvent in 1994, remains the most prominent example of such an event. Although other cities, most notably Bridgeport, Conn., and Pittsburgh, have threatened such action.

SIX CHARGED. "It's mainly a way to throw gasoline on the fire and get everyone to deal with the problems," says Carl Jacobs, a director of municipal-bond ratings at Standard & Poors, which suspended its San Diego rating last year, pending completion of an outside audit of the city's finances.

Meantime, the fallout from the pension scandal continues. On May 17, the San Diego County District Attorney Bonnie M. Dumanis charged six current or former pension-fund board members with felony charges. Dumanis claimed they violated state laws by voting to limit city contributions to the fund at the same time they were personally benefiting by increasing their own pensions.

"As a former judge," says Murphy, "I believe people should not rush to judgment."

Editor's note: This updates a BusinessWeek Online story that originally appeared on Apr. 26, 2005 By Christopher Palmeri in Los Angeles